EFIC: US Shale Gas Could Threaten Australian LNG

Potential US gas exports do not represent a big threat to Australian LNG projects currently under construction. But this could change if there are large cost overruns at the Australian projects, or technological improvements significantly lower the long-run break-even price of US shale gas deposits, according to Australia’s Export Finance and Insurance Corporation (EFIC).

EFIC said in a report that a large wedge has opened up between LNG prices in Asia and gas prices in the US. In April 2012, the difference between the Japanese LNG price and the US gas price was $14/mmbtu. The Asian gas price has risen in response to two things: a jump in Japanese demand — with gas-fired power stations helping to offset lost nuclear capacity — and high oil prices. Meanwhile, the collapse in the US gas price reflects a surge in domestic gas production, driven by a shale gas ‘revolution’ that has made feasible the extraction of vast reserves of unconventional gas in the US and Canada.

With such a large price differential having opened up, LNG exports from North America to Asia have become financially attractive. This has fortified the backers of several LNG export projects in both the US and Canada. The US Energy Information Administration now expects that the US will become an LNG exporter after 2015, as a few of these projects come on stream. How times change. As recently as 2005, the EIA expected the US would become a significant LNG importer, EFIC said.

This likelihood of US exports has raised the possibility that exports to Asia from planned Australian LNG projects could be displaced.  But this risk seems small.  First, the EIA expects that the US will  be only a small LNG exporter.  Second, US prices are expected to rise from current lows, reaching US$4-5/mmbtu by 2016.  At these prices, and after adding in liquefaction and transport costs, the commercial breakeven price of US LNG landed in Asia would be similar to the average breakeven price of Australian LNG projects under construction, currently around US$8-10/mmbtu.  This suggests that even if US exports are significant, North American LNG would only cap prices in Asia and lower regional price differentials, not displace the average new Australian supplier.

The key risk to this conclusion is Austrailan construction costs.  The large expansion of Australian LNG export capacity is placing strain on labour markets and infrastructure, which may push up capex costs and move projects further up the world LNG cost curve.  Cost overruns also generally imply project delays; delays that could trigger re-negotiation clauses in supply agreements, exposing projects to price and buyer risk at a time when alternative sources of gas are more plentiful, EFIC said.

Historically, cost and time overruns in the LNG sector have been a frequent occurrence.  Of the LNG projects completed over 2000-2010, JP Morgan estimates that 34% were delivered behind schedule and 38% were over budget.

The conclusion that US shale gas is not likely to be a dramatically cheaper alternative source of LNG for Asian buyers is also based on forecasts of the long run US domestic gas price.  The domestic price of US$4-5/mmbtu by 2016 is based on the forward curve – contracts for future gas delivery are traded on the Chicago Mercantile Exchange. Similarly, the EIA predicts that the Henry Hub benchmark price will rise to around US$4.70/mmbtu in 2016.  Part of the rise is based on the fact that the current low price is below the breakeven price of many wells in the US, EFIC said.

Still, shale gas extraction technologies are rapidly improving, making it difficult to confidently predict the long-run breakeven prices of US shale deposits and the level of recoverable reserves.  This raises the risk that long run US gas prices could fall below US$4-5/mmbtu and the amount of exportable gas could correspondingly swell.

The net result?  US shale gas would become a more compelling alternative source of LNG supply to Asian buyers, even to those concerned about the security of supply and volatility in the Henry Hub price, EFIC said.

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LNG World News Staff, May 22, 2012; Image: Woodside